Has Krispy Kreme Become the Perfect Stock?

Finding companies that have all the right stuff can produce winners.

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Krispy Kreme(NYSE: KKD) fits the bill.

The quest for perfectionStocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.

Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.

Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.

Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.

Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.

Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Krispy Kreme.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

(2.1%)

Fail

1-Year Revenue Growth > 12%

8.7%

Fail

Margins

Gross Margin > 35%

14.5%

Fail

Net Margin > 15%

40.1%

Pass

Balance Sheet

Debt to Equity < 50%

10.9%

Pass

Current Ratio > 1.3

2.77

Pass

Opportunities

Return on Equity > 15%

97.7%

Pass

Valuation

Normalized P/E < 20

29.25

Fail

Dividends

Current Yield > 2%

0%

Fail

5-Year Dividend Growth > 10%

0%

Fail

Total Score

4 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Krispy Kreme last year, the company has actually picked up a point. But the gain came from a tax benefit that inflated net margins, and investors haven't seen any reward from their shares, which are down about 20% over the past year.

Krispy Kreme is one example of a phenomenon that has happened all too often to companies: After seeing a huge growth spurt, the donut retailer got ahead of itself, expanding too fast and getting buried by an avalanche of debt. For years, the company has dug itself out from its mistakes slowly but surely, and even as competition from Dunkin' Brands(Nasdaq: DNKN) has heated up, Krispy Kreme's debt is down to very manageable levels.

But investors have gotten impatient for a faster recovery. Back in March, Krispy Kreme stock dropped by 10% even after the company announced a solid earnings report, with profit projections for fiscal 2013 that met or exceeded analyst expectations. As much as shareholders would like to see Krispy Kreme return to its fast-growth days, the reality is that small gains like this will be what brings the donut-seller back in the long run.

Even incremental gains don't come easy. Krispy Kreme is seeking to emulate Dunkin' by boosting its coffee offerings, but already, Starbucks(Nasdaq: SBUX) and Green Mountain Coffee Roasters(Nasdaq: GMCR) have made things difficult for Dunkin' in that highly competitive space, and Krispy Kreme won't find it any easier to break into the market. Meanwhile, Panera Bread's (Nasdaq: PNRA)baked goods have seen consistent growth in recent years, and with a broader range of products, Panera appeals to a wider audience than Krispy Kreme.

For Krispy Kreme to keep improving, it needs to find a workable growth strategy that will bring back customers who backed away from the company after the donut craze ran its course. That's possible, but it may take a while before Krispy Kreme finds the magic answer to shine up its business once again.

Keep searchingNo stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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